STARBUCKS CORP FORM 10-Q. (Quarterly Report) Filed 01/27/15 for the Period Ending 12/28/14

Transcription

1 STARBUCKS CORP FORM 10-Q (Quarterly Report) Filed 01/27/15 for the Period Ending 12/28/14 Address P O BOX SEATTLE, WA, Telephone CIK Symbol SBUX SIC Code Miscellaneous Food Preparations and Kindred Products Fiscal Year 09/27 Copyright 2018, EDGAR Online, a division of Donnelley Financial Solutions. All Rights Reserved. Distribution and use of this document restricted under EDGAR Online, a division of Donnelley Financial Solutions, Terms of Use.

2 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended December 28, TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 OR For the transition period from to. Commission File Number: Starbucks Corporation (Exact Name of Registrant as Specified in its Charter) Washington (State or Other Jurisdiction of Incorporation or Organization) 2401 Utah Avenue South, Seattle, Washington (Address of principal executive offices) (206) (Registrant s Telephone Number, including Area Code) (IRS Employer Identification No.) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T ( of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes No Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. Large accelerated filer Accelerated filer Non-accelerated filer (Do not check if a smaller reporting company) Smaller reporting company Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes No Indicate the number of shares outstanding of each of the issuer s classes of common stock, as of the latest practicable date. Title Shares Outstanding as of January 21, 2015 Common Stock, par value $0.001 per share million

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4 STARBUCKS CORPORATION FORM 10-Q For the Quarterly Period Ended December 28, Table of Contents PART I. FINANCIAL INFORMATION Item 1 Financial Statements (Unaudited): 3 Condensed Consolidated Statements of Earnings 3 Condensed Consolidated Statements of Comprehensive Income 4 Condensed Consolidated Balance Sheets 5 Condensed Consolidated Statements of Cash Flows 6 Index For Notes to Condensed Consolidated Financial Statements 7 Notes to Condensed Consolidated Financial Statements 8 Item 2 Management s Discussion and Analysis of Financial Condition and Results of Operations 21 Item 3 Quantitative and Qualitative Disclosures About Market Risk 33 Item 4 Controls and Procedures 33 PART II. OTHER INFORMATION Item 1 Legal Proceedings 33 Item 1A Risk Factors 33 Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 34 Item 6 Exhibits 35 Signatures 36

5 Item 1. Financial Statements PART I FINANCIAL INFORMATION STARBUCKS CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (in millions, except per share data) (unaudited) See Notes to Condensed Consolidated Financial Statements 3 Quarter Ended Net revenues: Company-operated stores $ 3,772.8 $ 3,343.8 Licensed stores CPG, foodservice and other Total net revenues 4, ,239.6 Cost of sales including occupancy costs 1, ,795.1 Store operating expenses 1, ,175.1 Other operating expenses Depreciation and amortization expenses General and administrative expenses Litigation credit (20.2) Total operating expenses 3, ,477.2 Income from equity investees Operating income Gain resulting from acquisition of joint venture Interest income and other, net Interest expense (16.3) (14.5) Earnings before income taxes 1, Income tax expense Net earnings including noncontrolling interests Net earnings/(loss) attributable to noncontrolling interests 1.4 Net earnings attributable to Starbucks $ $ Earnings per share - basic $ 1.31 $ 0.72 Earnings per share - diluted $ 1.30 $ 0.71 Weighted average shares outstanding: Basic Diluted Cash dividends declared per share $ 0.32 $ 0.26 Dec 29, 2013

6 STARBUCKS CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (in millions, unaudited) Quarter Ended Net earnings including noncontrolling interests $ $ Other comprehensive income/(loss), net of tax: Unrealized holding gains/(losses) on available-for-sale securities (0.6) (2.0) Tax (expense)/benefit Unrealized gains/(losses) on cash flow hedging instruments Tax (expense)/benefit (12.9) (3.9) Unrealized gains/(losses) on net investment hedging instruments Tax (expense)/benefit (1.6) (3.6) Translation adjustment (156.4) (30.4) Tax (expense)/benefit Reclassification adjustment for net (gains)/losses realized in net earnings for available-for-sale securities, hedging instruments, and translation adjustment (59.8) 7.6 Tax expense/(benefit) 17.2 (0.1) Other comprehensive income/(loss) (154.1) 1.7 Comprehensive income including noncontrolling interests Comprehensive income/(loss) attributable to noncontrolling interests (30.4) Comprehensive income attributable to Starbucks $ $ Dec 29, 2013 See Notes to Condensed Consolidated Financial Statements 4

7 STARBUCKS CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (in millions, except per share data) (unaudited) ASSETS Current assets: Cash and cash equivalents $ 1,857.0 $ 1,708.4 Short-term investments Accounts receivable, net Inventories 1, ,090.9 Prepaid expenses and other current assets Deferred income taxes, net Total current assets 4, ,168.7 Long-term investments Equity and cost investments Property, plant and equipment, net 3, ,519.0 Deferred income taxes, net Other long-term assets Other intangible assets Goodwill 1, TOTAL ASSETS $ 12,351.1 $ 10,752.9 LIABILITIES AND EQUITY Current liabilities: Accounts payable $ $ Accrued liabilities 1, ,514.4 Insurance reserves Deferred revenue 1, Total current liabilities 3, ,038.7 Long-term debt 2, ,048.3 Other long-term liabilities Total liabilities 6, ,479.2 Shareholders equity: Common stock ($0.001 par value) authorized, 1,200.0 shares; issued and outstanding, shares and shares, respectively Additional paid-in capital Retained earnings 5, ,206.6 Accumulated other comprehensive income/(loss) (97.0) 25.3 Total shareholders equity 5, ,272.0 Noncontrolling interests Total equity 6, ,273.7 TOTAL LIABILITIES AND EQUITY $ 12,351.1 $ 10,752.9 Sep 28, See Notes to Condensed Consolidated Financial Statements 5

8 STARBUCKS CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in millions, unaudited) Quarter Ended OPERATING ACTIVITIES: Net earnings including noncontrolling interests $ $ Adjustments to reconcile net earnings to net cash provided/(used) by operating activities: Depreciation and amortization Deferred income taxes, net Income earned from equity method investees (35.6) (29.7) Distributions received from equity method investees Gain resulting from acquisition of joint venture (390.6) Stock-based compensation Excess tax benefit on share-based awards (53.3) (72.6) Other Cash provided/(used) by changes in operating assets and liabilities: Accounts receivable (9.3) (26.1) Inventories Accounts payable (20.8) (41.8) Accrued litigation charge (2,763.9) Income taxes payable, net (17.8) Accrued liabilities and insurance reserves 40.3 (28.9) Deferred revenue Prepaid expenses, other current assets and other assets Net cash provided/(used) by operating activities 1,425.2 (1,401.9) INVESTING ACTIVITIES: Purchase of investments (133.1) (577.2) Sales of investments Maturities and calls of investments Acquisitions, net of cash acquired (284.3) Additions to property, plant and equipment (291.8) (256.1) Other 1.8 (19.4) Net cash used by investing activities (522.5) (193.3) FINANCING ACTIVITIES: Proceeds from issuance of long-term debt Cash restricted for purchase of noncontrolling interest (257.6) Proceeds from issuance of common stock Excess tax benefit on share-based awards Cash dividends paid (239.5) (195.9) Repurchase of common stock (215.0) (38.5) Minimum tax withholdings on share-based awards (71.8) (74.4) Other (1.8) (5.0) Net cash (used)/provided by financing activities (668.3) Effect of exchange rate changes on cash and cash equivalents (85.8) (3.6) Net increase/(decrease) in cash and cash equivalents (1,029.9) CASH AND CASH EQUIVALENTS: Beginning of period 1, ,575.7 End of period $ 1,857.0 $ 1,545.8 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the period for: Dec 29, 2013

9 Interest, net of capitalized interest $ 19.7 $ 0.2 Income taxes, net of refunds $ $ 37.4 See Notes to Condensed Consolidated Financial Statements 6

10 STARBUCKS CORPORATION INDEX FOR NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Note 1 Summary of Significant Accounting Policies 8 Note 2 Acquisition 8 Note 3 Derivative Financial Instruments 11 Note 4 Fair Value Measurements 14 Note 5 Inventories 16 Note 6 Supplemental Balance Sheet Information 16 Note 7 Debt 17 Note 8 Equity 17 Note 9 Employee Stock Plans 19 Note 10 Earnings per Share 19 Note 11 Segment Reporting 20 Note 12 Subsequent Event 20 7

11 Note 1: Summary of Significant Accounting Policies Financial Statement Preparation STARBUCKS CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) The unaudited condensed consolidated financial statements as of December 28,, and for the quarter s ended December 28, and December 29, 2013, have been prepared by Starbucks Corporation under the rules and regulations of the Securities and Exchange Commission ( SEC ). In the opinion of management, the financial information for the quarter s ended December 28, and December 29, 2013 reflects all adjustments and accruals, which are of a normal recurring nature, necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods. In this Quarterly Report on Form 10-Q ( 10-Q ) Starbucks Corporation is referred to as Starbucks, the Company, we, us or our. The financial information as of September 28, is derived from our audited consolidated financial statements and notes for the fiscal year ended September 28, ( fiscal ) included in Item 8 in the Fiscal Annual Report on Form 10-K (the 10-K ). The information included in this 10-Q should be read in conjunction with the footnotes and management s discussion and analysis of the consolidated financial statements in the 10-K. The results of operations for the quarter ended December 28, are not necessarily indicative of the results of operations that may be achieved for the entire fiscal year ending September 27, 2015 ("fiscal 2015"). Recent Accounting Pronouncements In May, the Financial Accounting Standards Board ("FASB") issued guidance outlining a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers that supersedes most current revenue recognition guidance. This guidance requires an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Additionally, this guidance expands related disclosure requirements. The guidance will become effective for us at the beginning of our first quarter of fiscal 2018 and will require full or modified retrospective application. We are currently evaluating the impact this guidance will have on our consolidated financial statements as well as the expected adoption method. In April, the FASB issued guidance that changes the criteria for reporting discontinued operations. To qualify as a discontinued operation under the amended guidance, a component or group of components of an entity that has been disposed of or is classified as held for sale must represent a strategic shift that has or will have a major effect on the entity's operations and financial results. This guidance also expands related disclosure requirements. The guidance will become effective for us at the beginning of our first quarter of fiscal We do not expect the adoption of this guidance will have a material impact on our consolidated financial statements. In July 2013, the FASB issued guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This guidance requires the unrecognized tax benefit to be presented in the financial statements as a reduction to a deferred tax asset. When a deferred tax asset is not available, or the asset is not intended to be used for this purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and not netted with a deferred tax asset. The guidance became effective for us at the beginning of our first quarter of fiscal 2015 and did not have a material impact on our consolidated financial statements. In March 2013, the FASB issued guidance on a parent's accounting for the cumulative translation adjustment upon derecognition of certain subsidiaries or groups of assets within a foreign entity or of an investment in a foreign entity. This guidance requires a parent to release any related cumulative translation adjustment into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. The guidance became effective for us at the beginning of our first quarter of fiscal 2015 and did not have a material impact on our consolidated financial statements. Note 2: Acquisition On September 23,, we entered into a tender offer bid agreement with Starbucks Coffee Japan, Ltd. ("Starbucks Japan"), at the time a 39.5% owned equity method investment, and our joint venture partner, Sazaby League, Ltd. ("Sazaby"), to acquire the remaining 60.5% ownership interest in Starbucks Japan. Acquiring Starbucks Japan further leverages our existing infrastructure to continue disciplined retail store growth and expand our presence into other channels in the Japan market, such as consumer packaged goods ("CPG"), licensing and foodservice. This acquisition is structured as a two-step tender offer. 8

12 On October 31,, we acquired Sazaby's 39.5% ownership interest in Starbucks Japan through the first tender offer step for 55 billion in cash, or $509 million with Japanese yen converted into U.S. dollars at a reference conversion rate of JPY to USD, based on a spot rate that approximates the rate as of the acquisition date, bringing our total ownership in Starbucks Japan to a controlling 79% interest. The estimated fair values of the assets acquired, liabilities assumed and the noncontrolling interest are based on preliminary valuation as of the October 31, acquisition date and are subject to change as additional information about the fair value of assets acquired, liabilities assumed and noncontrolling interest become available. The following table summarizes the allocation of the total consideration to the fair values of the assets acquired and liabilities assumed as of October 31, (in millions) : Consideration: Cash paid for Sazaby's 39.5% equity interest $ Fair value of our preexisting 39.5% equity interest Total consideration $ 1,085.7 Fair value of assets acquired and liabilities assumed: Cash and cash equivalents $ Accounts receivable, net 37.4 Inventories 26.4 Prepaid expenses and other current assets 35.7 Deferred income taxes, net (current) 23.4 Property, plant and equipment Other long-term assets Other intangible assets Goodwill Total assets acquired 1,910.2 Accounts payable (54.5) Accrued liabilities (119.9) Deferred revenue (36.5) Deferred income taxes (noncurrent) (92.9) Other long-term liabilities (109.6) Total liabilities assumed (413.4) Noncontrolling interest (411.1) Total consideration $ 1,085.7 The assets acquired and liabilities assumed are reported within our China/Asia Pacific segment. Other current and long-term assets acquired primarily include various deposits, specifically lease and key money deposits. Accrued liabilities and other long-term liabilities assumed primarily include the financing obligations associated with the build-to-suit leases discussed below, as well as asset retirement obligations. The intangible assets are definite-lived and include reacquired rights, licensing agreements with Starbucks Japan's current licensees and Starbucks Japan's customer loyalty program. The reacquired rights of $305.0 million represent the fair value, calculated over the remaining original contractual period, to exclusively operate licensed Starbucks retail stores in Japan. These rights will be amortized on a straight-line basis through March 2021, or over a period of approximately 6.4 years. The licensing agreements were valued at $15.0 million and will be amortized on a straight-line basis over a period of approximately 10.9 years, which is based on the remaining terms of the respective licensing agreements. The customer loyalty program was valued at $3.0 million and will be amortized on a straight-line basis over a period of 4.0 years, which represents the period during which we expect to benefit from these customer relationships. 9

13 Below is a tabular summary of the acquired intangible assets as of December 28,, for which the balances in total are $32.9 million lower than as of the October 31, acquisition date due to foreign currency translation (in millions) : Amortization expense for these definite-lived intangible assets was $7.7 million for the quarter ended December 28, and is estimated to be approximately $45 million each year for the next five years and approximately $58 million thereafter. The $815.6 million of goodwill represents the intangible assets that do not qualify for separate recognition and primarily includes the acquired current customer base, the acquired workforce including store partners in the region that have strong relationships with these customers, the existing geographic retail and online presence, and the expected geographic presence in new channels. The goodwill was allocated to the China/Asia Pacific segment and is not deductible for income tax purposes. Due to foreign currency translation, the balance of goodwill related to the acquisition declined $83.0 million to $732.6 million as of December 28,. As a part of this acquisition we acquired a significant number of operating leases, including $7.5 million of favorable lease assets, which are included in prepaid expenses and other current assets and other long-term assets, and $15.5 million of unfavorable lease liabilities, which are included in accrued liabilities and other long-term liabilities on the consolidated balance sheets. The fair values of these assets and liabilities were determined based on market terms for similar leases as of the date of the acquisition, and will be amortized on a straight-line basis as rent expense, or a reduction of rent expense, respectively, in cost of sales including occupancy costs in the consolidated statements of earnings over the remaining terms of the leases, for which the weighted-average period is 9.4 years. We recorded a $0.2 million net reduction of rent expense during the first quarter of fiscal 2015 in connection with the leases acquired. Additionally, we acquired a number of build-to-suit lease arrangements that are accounted for as financing leases. Starbucks Japan is the deemed owner of buildings under build-to-suit lease arrangements since Starbucks Japan has significant continuing involvement with the respective lessors and does not qualify for sales recognition during the lease term under sale-leaseback accounting guidance. Accordingly, we have recorded the acquired buildings in property, plant and equipment, and the assumed offsetting lease financing obligations, representing the related future minimum lease payments, in other long-term liabilities, with the current portion recorded in accrued liabilities on the consolidated balance sheets. These financing obligations will be amortized based on the terms of the related lease agreements. The table below summarizes our estimated minimum future rental payments under the acquired non-cancelable operating leases and lease financing arrangements as of December 28, (in millions): The fair value of the noncontrolling interest in Starbucks Japan was estimated by applying the market approach. Specifically, the fair value was determined based on the purchase price we expect to pay for the remaining 21% noncontrolling interest, which is comprised of a set market price and a premium above the market price. The market price premium is a customary business practice for public tender offer transactions in Japan, so we believe this is what a market participant would pay and should be included in the fair value determination. As a result of this acquisition, we remeasured the carrying value of our preexisting 39.5% equity method investment to fair value, which resulted in a pre-tax gain of $390.6 million that was presented separately as gain resulting from acquisition of joint venture within other income in the consolidated statements of earnings. The fair value of $577.0 million was calculated using an average 10 Gross Carrying Amount Accumulated Amortization Net Carrying Amount Reacquired rights $ $ (7.1) $ Licensing agreements 13.5 (0.2) 13.3 Customer loyalty program 2.7 (0.1) 2.6 Total acquired definite-lived intangible assets $ $ (7.4) $ Operating Leases Lease Financing Arrangements Year 1 $ 78.4 $ 2.9 Year Year Year Year Thereafter Total minimum lease payments $ $ 39.3

14 of the income and market approach. The income approach fair value measurement was based on significant inputs that are not observable in the market and thus represents a fair value measurement categorized within Level 3 of the fair value hierarchy. Key assumptions used in estimating future cash flows included projected revenue growth and operating expenses, as well as the selection of an appropriate discount rate. Estimates of revenue growth and operating expenses were based on internal projections and considered the historical performance of stores, local market economics and the business environment impacting the stores' performance. The discount rate applied was based on Starbucks Japan's weighted-average cost of capital and included a company-specific risk premium. The market approach fair value measurement was based on the implied fair value of Starbucks Japan using the purchase price of Sazaby's 39.5% ownership interest and the expected purchase price of the 21% remaining noncontrolling interest. We began consolidating Starbucks Japan's results of operations and cash flows into our consolidated financial statements beginning after October 31,. For the quarter ended December 28,, Starbucks Japan's revenue and net earnings included in our consolidated statements of earnings were $192.8 million and $20.3 million, respectively. The following table provides the supplemental pro forma revenue and net earnings of the combined entity had the acquisition date of Starbucks Japan been the first day of our first quarter of fiscal rather than during our first quarter of fiscal 2015 (in millions) : The amounts in the supplemental pro forma earnings for the periods presented above fully eliminate intercompany transactions, apply our accounting policies and reflect adjustments for additional occupancy costs, depreciation and amortization that would have been charged assuming the same fair value adjustments to leases, property, plant and equipment and acquired intangibles had been applied on September 30, These pro forma results are unaudited and are not necessarily indicative of results of operations that would have occurred had the acquisition actually occurred in the prior year period or indicative of the results of operations for any future period. We initiated the second tender offer step on November 10, to acquire the remaining 21% ownership interest held by the public shareholders and option holders of Starbucks Japan's common stock, with the objective of acquiring all of the remaining outstanding shares including outstanding stock options. At the close of the second tender offer period on December 22,, we funded the second tender offer step to acquire an additional 14.7% ownership interest for 31 billion in cash, or $258 million with Japanese yen converted into U.S. dollars at a reference conversion rate of JPY to USD. However, we did not complete the second tender offer nor obtain control of these shares until the settlement date of December 29,, which was the first day of our second quarter of fiscal The amount transferred in the first quarter of fiscal 2015 was included in restricted cash within prepaid expenses and other current assets on our consolidated balance sheets. Because we did not own the 21% of minority shareholders interests as of December 28,, the related portion of net earnings was presented as net earnings attributable to noncontrolling interests in our consolidated statement of earnings for the quarter ended December 28,. Subsequent to the completion of the second tender offer step, we commenced a cash-out procedure under Japanese law (the "Cash-out") that will allow us to acquire all remaining shares (an approximate 6.3% interest). At the conclusion of the Cash-out, which we expect to complete during the first half of calendar 2015, we will own 100% of Starbucks Japan. The expected purchase price for the Cash-out is 13.5 billion, or approximately $115 million, with Japanese yen converted into U.S. dollars at a reference conversion rate of JPY to USD, which was based on the spot rate on our filing date, January 27, During the first quarter of fiscal 2015, we incurred approximately $11 million in acquisition-related costs, such as regulatory, legal, and advisory fees, which we have recorded within unallocated corporate general and administrative expenses. Note 3: Derivative Financial Instruments Interest Rates Depending on market conditions, we enter into interest rate swap agreements to hedge the variability in cash flows due to changes in the benchmark interest rate related to anticipated debt issuances. These agreements are cash settled at the time of the pricing of the related debt. The effective portion of the derivative's gain or loss is recorded in accumulated other comprehensive income ("AOCI") and is subsequently reclassified to interest expense over the life of the related debt. 11 Quarter Ended - Pro Forma (unaudited) Dec 29, 2013 Revenue $ 4,895.0 $ 4,526.7 Net earnings attributable to Starbucks (1) (1) The pro forma net earnings attributable to Starbucks for the first quarter of fiscal included the acquisition-related gain of $390.6 million and $11.6 million of transaction and integration costs.

15 During the first quarter of fiscal 2015, we entered into forward-starting interest rate swap agreements with an aggregate notional amount of $250.0 million related to a potential debt issuance in fiscal Foreign Currency To reduce cash flow volatility from foreign currency fluctuations, we enter into forward and swap contracts to hedge portions of cash flows of anticipated revenue streams, inventory purchases, and principal and interest payments on intercompany loans in currencies other than the entity's functional currency. The effective portion of the derivative's gain or loss is recorded in AOCI and is subsequently reclassified to revenue, cost of sales, or interest income and other, net, respectively, when the hedged exposure affects net earnings. In connection with the acquisition of Starbucks Japan that is discussed in Note 2, Acquisition, we entered into cross-currency swap contracts during the first quarter of fiscal 2015 to hedge the foreign currency translation risk of certain yen-denominated intercompany loans with a total notional value of 73.5 billion, or approximately $610 million as of December 28,. Gains and losses from these swaps offset the changes in value of interest and principal payments as a result of changes in foreign exchange rates, which are also recorded in net interest income and other in the consolidated statements of earnings. These swaps have been designated as cash flow hedges and mature in September 2016 and November 2024 at the same time as the related loans. There are no credit-risk-related contingent features associated with these swaps, although we may hold or post collateral depending upon the gain or loss position of the swap agreement. We also enter into forward contracts to hedge the foreign currency exposure of our net investment in certain foreign operations. The effective portion of the derivative's gain or loss is recorded in AOCI and will be subsequently reclassified to net earnings when the hedged net investment is either sold or substantially liquidated. As a result of our acquisition of Starbucks Japan, we reclassified the pretax cumulative net gains in AOCI of $7.2 million related to our net investment derivative instruments used to hedge our preexisting 39.5% equity method investment in Starbucks Japan into earnings, which was included in the gain resulting from acquisition of joint venture line item in the consolidated statements of earnings. These gains offset the cumulative translation adjustment loss balance associated with our preexisting investment included in the calculation of the remeasurement gain, which is described further in Note 2, Acquisition. To mitigate the foreign exchange risk of certain balance sheet items, we enter into foreign currency forward contracts that are not designated as hedging instruments. Gains and losses from these derivatives are largely offset by the financial impact of translating foreign currency denominated payables and receivables; both are recorded in net interest income and other. Commodities Depending on market conditions, we enter into coffee futures contracts and collars (the combination of a purchased call option and a sold put option) to hedge a portion of anticipated cash flows under our price-to-be-fixed green coffee contracts, which are described further in Note 5, Inventories. The effective portion of the derivative's gain or loss is recorded in AOCI and is subsequently reclassified to cost of sales when the hedged exposure affects net earnings. To mitigate the price uncertainty of a portion of our future purchases of dairy products and diesel fuel, we enter into dairy swap contracts, futures and collars, as well as instruments used to hedge diesel fuel exposure that are not designated as hedging instruments. Gains and losses from these derivatives are recorded in net interest income and other and help to offset price fluctuations on our dairy purchases and the financial impact of diesel fuel fluctuations on our shipping costs, which are included in cost of sales. Gains and losses on derivative contracts designated as hedging instruments included in AOCI and expected to be reclassified into earnings within 12 months, net of tax ( in millions ): Net Gains/(Losses) Included in AOCI Net Gains/(Losses) Expected to be Reclassified from AOCI into Earnings within 12 Months Contract Remaining Maturity (Months) Cash Flow Hedges: Interest rates $ 35.8 $ 36.4 $ Cross-currency swaps (20.1) 120 Foreign currency - other Coffee (1.8) (0.7) (1.2) 11 Net Investment Hedges: Foreign currency Sep 28, 12

16 Pretax gains and losses on derivative contracts designated as hedging instruments recognized in other comprehensive income ("OCI") and reclassifications from AOCI to earnings ( in millions ): Gains/(Losses) Recognized in OCI Before Reclassifications Quarter Ended Gains/(Losses) Reclassified from AOCI to Earnings Cash Flow Hedges: Interest rates $ 0.3 $ 0.5 $ 1.3 $ 1.2 Cross-currency swaps Foreign currency - other Coffee (2.8) (0.3) (1.6) (10.0) Net Investment Hedges: Foreign currency Dec 29, 2013 Dec 29, 2013 Pretax gains and losses on derivative contracts not designated as hedging instruments recognized in earnings ( in millions ): Gains/(Losses) Recognized in Earnings Quarter Ended Dec 29, 2013 Foreign currency - other $ 18.6 $ (0.9) Coffee Dairy (4.5) 4.5 Diesel fuel (7.6) Notional amounts of outstanding derivative contracts (in millions) : Sep 28, Interest rates $ 250 $ Cross-currency swaps 610 Foreign currency - other Coffee Dairy Diesel fuel The fair values of our derivative assets and liabilities are included in Note 4, Fair Value Measurements, and additional disclosures related to cash flow and net investment hedge gains and losses included in accumulated other comprehensive income, as well as subsequent reclassifications to earnings, are included in Note 8, Equity. 13

17 Note 4: Fair Value Measurements Assets and Liabilities Measured at Fair Value on a Recurring Basis (in millions): Balance at Fair Value Measurements at Reporting Date Using Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Assets: Cash and cash equivalents $ 1,857.0 $ 1,857.0 $ $ Short-term investments: Available-for-sale securities Corporate debt securities Foreign government obligations U.S. government treasury securities Total available-for-sale securities Trading securities Total short-term investments Prepaid expenses and other current assets: Derivative assets Long-term investments: Available-for-sale securities Agency obligations Corporate debt securities Auction rate securities Foreign government obligations U.S. government treasury securities State and local government obligations Mortgage and asset-backed securities Total long-term investments Other assets: Derivative assets Total $ 2,383.7 $ 2,040.0 $ $ 10.1 Liabilities: Accrued liabilities: Derivative liabilities $ 16.7 $ 4.3 $ 12.4 $ Other long-term liabilities: Derivative liabilities Total $ 25.1 $ 4.3 $ 20.8 $ 14

18 Assets: There were no transfers between levels and there was no significant activity within Level 3 instruments during the periods presented. The fair values of any financial instruments presented above exclude the impact of netting assets and liabilities when a legally enforceable master netting agreement exists. Gross unrealized holding gains and losses on investments were not material as of December 28, and September 28,. Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis Balance at Sep 28, Fair Value Measurements at Reporting Date Using Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Assets and liabilities recognized or disclosed at fair value in the consolidated financial statements on a nonrecurring basis include items such as property, plant and equipment, goodwill and other intangible assets, equity and cost method investments, and other assets. These assets are measured at fair value if determined to be impaired. During the quarter s ended December 28, and December 29, 2013, there were no material fair value adjustments. The estimated fair value of our long-term debt based on the quoted market price (Level 2) is included at Note 7, Debt. Significant Unobservable Inputs (Level 3) Cash and cash equivalents $ 1,708.4 $ 1,708.4 $ $ Short-term investments: Available-for-sale securities Corporate debt securities Foreign government obligations U.S. government treasury securities State and local government obligations Certificates of deposit Total available-for-sale securities Trading securities Total short-term investments Prepaid expenses and other current assets: Derivative assets Long-term investments: Available-for-sale securities Agency obligations Corporate debt securities Auction rate securities Foreign government obligations U.S. government treasury securities State and local government obligations Mortgage and asset-backed securities Total long-term investments Other assets: Derivative assets Total $ 2,208.9 $ 1,887.2 $ $ 13.8 Liabilities: Accrued liabilities: Derivative liabilities $ 2.4 $ 0.4 $ 2.0 $ 15

19 Note 5: Inventories (in millions) Sep 28, Dec 29, 2013 Coffee: Unroasted $ $ $ Roasted Other merchandise held for sale Packaging and other supplies Total $ 1,018.3 $ 1,090.9 $ Other merchandise held for sale includes, among other items, serveware and tea. Inventory levels vary due to seasonality, commodity market supply and price fluctuations. As of December 28,, we had committed to purchasing green coffee totaling $564 million under fixed-price contracts and an estimated $416 million under price-to-be-fixed contracts. As of December 28,, approximately $15 million of our price-to-be-fixed contracts were effectively fixed through the use of futures contracts and approximately $17 million were price-protected through the use of collar instruments. Price-to-be-fixed contracts are purchase commitments whereby the quality, quantity, delivery period, and other negotiated terms are agreed upon, but the date, and therefore the price, at which the base C coffee commodity price component will be fixed has not yet been established. For these types of contracts, either Starbucks or the seller has the option to fix the base C coffee commodity price prior to the delivery date. Until prices are fixed, we estimate the total cost of these purchase commitments. We believe, based on relationships established with our suppliers in the past, the risk of non-delivery on these purchase commitments is remote. Note 6: Supplemental Balance Sheet Information (in millions) Property, Plant and Equipment, net Sep 28, Land $ 46.7 $ 46.7 Buildings Leasehold improvements 5, ,858.4 Store equipment 1, ,493.3 Roasting equipment Furniture, fixtures and other 1, ,078.1 Work in progress Property, plant and equipment, gross 8, ,581.1 Accumulated depreciation (5,177.6) (5,062.1) Property, plant and equipment, net $ 3,822.3 $ 3,519.0 Accrued Liabilities Sep 28, Accrued compensation and related costs $ $ Accrued occupancy costs Accrued taxes Accrued dividend payable Other Total accrued liabilities $ 1,561.7 $ 1,

20 Note 7: Debt Components of long-term debt including the associated interest rates and related fair values ( in millions, except interest rates) : Issuance Face Value Sep 28, Estimated Fair Value Face Value Estimated Fair Value Stated Interest Rate Effective Interest Rate (1) 2016 notes $ $ 399 $ $ % 0.941% 2017 notes % 6.292% 2018 notes % 2.012% 2023 notes % 2.860% Total 2, ,184 2, ,164 Aggregate unamortized discount Total $ 2,048.4 $ 2,048.3 (1) Includes the effects of the amortization of any premium or discount and any gain or loss upon settlement of related treasury locks or forward-starting interest rate swaps utilized to hedge the interest rate risk prior to the debt issuance. The indentures under which the above notes were issued require us to maintain compliance with certain covenants, including limits on future liens and sale and leaseback transactions on certain material properties. As of December 28,, we were in compliance with all applicable covenants. Note 8: Equity Changes in total equity (in millions) : Attributable to Starbucks Quarter Ended Dec 29, 2013 Noncontrolling interest Total Equity Attributable to Starbucks Noncontrolling interest Total Equity Beginning balance of total equity $ 5,272.0 $ 1.7 $ 5,273.7 $ 4,480.2 $ 2.1 $ 4,482.3 Net earnings including noncontrolling interests Translation adjustment, net of reclassifications and tax (106.5) (31.8) (138.3) (18.7) (18.7) Unrealized gains/(losses), net of reclassifications and tax (15.8) (15.8) Other comprehensive income/(loss) (122.3) (31.8) (154.1) Stock-based compensation expense Exercise of stock options/vesting of RSUs Sale of common stock Repurchase of common stock (216.1) (216.1) (46.7) (46.7) Cash dividends declared (239.5) (239.5) (196.8) (196.8) Noncontrolling interest resulting from acquisition Ending balance of total equity $ 5,775.4 $ $ 6,157.8 $ 4,887.4 $ 2.1 $ 4,

21 Changes in accumulated other comprehensive income ("AOCI") by component, net of tax (in millions) : Quarter Ended December 28, Available-for- Sale Securities Cash Flow Hedges Net Investment Hedges Translation Adjustment Net gains/(losses) in AOCI, beginning of period $ (0.4) $ 46.3 $ 3.2 $ (23.8) $ 25.3 Net gains/(losses) recognized in OCI before reclassifications (0.4) (120.8) (79.7) Net (gains)/losses reclassified from AOCI to earnings (0.1) (52.2) (4.6) 14.3 (42.6) Other comprehensive income/(loss) attributable to Starbucks (0.5) (13.4) (1.9) (106.5) (122.3) Net gains/(losses) in AOCI, end of period $ (0.9) $ 32.9 $ 1.3 $ (130.3) $ (97.0) Total December 29, 2013 Net gains/(losses) in AOCI, beginning of period $ (0.5) $ 26.8 $ (12.9) $ 53.6 $ 67.0 Net gains/(losses) recognized in OCI before reclassifications (1.2) (18.7) (5.8) Net (gains)/losses reclassified from AOCI to earnings Other comprehensive income/(loss) attributable to Starbucks (1.2) (18.7) 1.7 Net gains/(losses) in AOCI, end of period $ (1.7) $ 42.2 $ (6.7) $ 34.9 $ 68.7 Impact of reclassifications from AOCI on the consolidated statements of earnings (in millions) : Quarter Ended AOCI Components Amounts Reclassified from AOCI Dec 29, 2013 Affected Line Item in the Statements of Earnings Gains/(losses) on cash flow hedges Interest rate hedges $ 1.3 $ 1.2 Interest expense Cross-currency swaps 63.1 Interest income and other, net Foreign currency hedges Revenues Foreign currency/coffee hedges (0.2) (9.8) Cost of sales including occupancy costs Gains/(losses) on net investment hedges (1) 7.2 Gain resulting from acquisition of joint venture Translation adjustment (2) Starbucks Japan (7.2) Gain resulting from acquisition of joint venture Other (7.1) Interest income and other, net 59.6 (7.6) Total before tax (17.1) 0.1 Tax (expense)/benefit $ 42.5 $ (7.5) Net of tax (1) Release of pretax cumulative net gains in AOCI related to our net investment derivative instruments used to hedge our preexisting 39.5% equity method investment in Starbucks Japan. (2) Release of cumulative translation adjustments to earnings upon sale or liquidation of foreign business. In addition to 1.2 billion shares of authorized common stock with $0.001 par value per share, the Company has authorized 7.5 million shares of preferred stock, none of which was outstanding as of December 28,.

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23 We repurchased 2.8 million shares of common stock at a total cost of $216.1 million, and 0.6 million shares at a total cost of $46.7 million for the quarter s ended December 28, and December 29, 2013, respectively. As of December 28,, 13.1 million shares remained available for repurchase under the current authorization. During the first quarter of fiscal 2015, our Board of Directors declared a quarterly cash dividend to shareholders of $0.32 per share to be paid on February 20, 2015 to shareholders of record as of the close of business on February 5, Note 9: Employee Stock Plans As of December 28,, there were 47.2 million shares of common stock available for issuance pursuant to future equity-based compensation awards and 7.3 million shares available for issuance under our employee stock purchase plan. Stock-based compensation expense recognized in the consolidated statements of earnings (in millions) : Quarter Ended Dec 29, 2013 Options $ 12.5 $ 12.8 Restricted Stock Units ( RSUs ) Total stock-based compensation $ 51.9 $ 47.8 Stock option and RSU transactions from September 28, through December 28, ( in millions ): Stock Options Options outstanding/nonvested RSUs, September 28, Granted Options exercised/rsus vested (2.1) (2.4) Forfeited/expired (0.2) (0.2) Options outstanding/nonvested RSUs, December 28, Total unrecognized stock-based compensation expense, net of estimated forfeitures, as of December 28, RSUs $ 53.2 $ Note 10: Earnings per Share Calculation of net earnings per common share ( EPS ) basic and diluted ( in millions, except EPS ): Quarter Ended Dec 29, 2013 Net earnings attributable to Starbucks $ $ Weighted average common shares outstanding (for basic calculation) Dilutive effect of outstanding common stock options and RSUs Weighted average common and common equivalent shares outstanding (for diluted calculation) EPS basic $ 1.31 $ 0.72 EPS diluted $ 1.30 $ 0.71 Potential dilutive shares consist of the incremental common shares issuable upon the exercise of outstanding stock options (both vested and non-vested) and unvested RSUs, calculated using the treasury stock method. The calculation of dilutive shares outstanding excludes out-of-themoney stock options (i.e., such options exercise prices were greater than the average market price of our common shares for the period) because their inclusion would have been antidilutive. Out-of-the-money stock options totaled approximately 3.9 million and 1.5 million as of December 28, and December 29, 2013, respectively. 19

24 Note 11: Segment Reporting Segment information is prepared on the same basis that our ceo, who is our chief operating decision maker, manages the segments, evaluates financial results, and makes key operating decisions. The table below presents financial information for our reportable operating segments and All Other Segments (in millions) : Quarter Ended (in millions) Americas EMEA December 28, China / Asia Pacific Channel Development All Other Segments Segment Total Total net revenues $ 3,366.9 $ $ $ $ $ 4,803.2 Depreciation and amortization expenses Income from equity investees Operating income ,143.5 December 29, 2013 Total net revenues $ 3,073.0 $ $ $ $ $ 4,239.6 Depreciation and amortization expenses Income from equity investees Operating income Reconciliation of total segment operating income to consolidated earnings before income taxes (in millions) : Quarter Ended Dec 29, 2013 Total segment operating income $ 1,143.5 $ Unallocated corporate operating expenses (228.0) (165.6) Consolidated operating income Gain resulting from acquisition of joint venture Interest income and other, net Interest expense (16.3) (14.5) Earnings before income taxes $ 1,299.5 $ Note 12: Subsequent Events As discussed in Note 2, Acquisition, on December 29,, which was the first day of our second quarter of fiscal 2015, we acquired an additional 14.7% ownership interest for 31 billion in cash, or $258 million with Japanese yen converted into U.S. dollars at a reference conversion rate of JPY to USD. Additionally, during the second quarter of fiscal 2015, we extended the duration of our credit facility, which is now set to mature on January 21, 2020, and amended certain facility fees and borrowing rates. 20

25 Item 2. Management s Discussion and Analysis of Financial Condition and Results of Operations CAUTIONARY STATEMENT PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 Certain statements herein, including statements regarding trends in or expectations relating to the expected effects of our initiatives and plans, as well as trends in or expectations regarding earnings per share, revenues, operating margins, comparable store sales, sales leverage, sales growth, profitability, expenses, dividends, share repurchases, other financial results, anticipated gains and costs related to the acquisition of Starbucks Japan, capital expenditures, investments in our store partners, scaling and expansion of international operations, shifts in our store portfolio to more licensed stores in EMEA, foreign currency translation, growth of China into one of our largest markets outside the U.S., profitable growth models and opportunities, emerging businesses, strategic acquisitions, commodity costs and our mitigation strategies, liquidity, cash flow from operations, use of cash and cash requirements, repatriation of cash to the U.S., the potential issuance of debt and applicable interest rate, anticipated store openings and closings, the health and growth of our business overall and of specific businesses or markets, benefits of recent initiatives, increased traffic to our stores, operational efficiencies, product innovation, offerings and distribution, tax rates, and economic conditions in the U.S. and international markets, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of Such statements are based on currently available operating, financial and competitive information and are subject to various risks and uncertainties. Actual future results and trends may differ materially depending on a variety of factors, including, but not limited to, fluctuations in U.S. and international economies and currencies, our ability to preserve, grow and leverage our brands, potential negative effects of material breaches of our information technology systems if any were to occur, costs associated with, and the successful execution of, the company's initiatives and plans, including the acquisition of Starbucks Japan, the acceptance of the company's products by our customers, the impact of competition, coffee, dairy and other raw materials prices and availability, the effect of legal proceedings, and other risks detailed in our filings with the SEC, including in Part I Item IA Risk Factors in the 10-K. A forward-looking statement is neither a prediction nor a guarantee of future events or circumstances, and those future events or circumstances may not occur. You should not place undue reliance on the forward-looking statements, which speak only as of the date of this report. We are under no obligation to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise. This information should be read in conjunction with the condensed consolidated financial statements and the notes included in Item 1 of Part I of this 10-Q and the audited consolidated financial statements and notes, and Management s Discussion and Analysis of Financial Condition and Results of Operations, contained in the 10-K. General Our fiscal year ends on the Sunday closest to September 30. All references to store counts, including data for new store openings, are reported net of store closures, unless otherwise noted. Overview Starbucks first quarter results reflect a strong start to fiscal 2015 with growth across all reportable segments. Consolidated total net revenues increased 13% to $4.8 billion, primarily driven by incremental revenues from the acquisition of Starbucks Japan, global comparable store sales growth of 5% and incremental revenue from 1,641 net new store openings over the last 12 months. Consolidated operating income increased $102 million, or 13%, to $916 million. Operating margin declined 10 basis points to 19.1%, due to the 80 basis point impact of our ownership change in Starbucks Japan, reflecting the change in accounting from a joint venture to a consolidated market and the acquisition-related transaction and integration costs. The decline in operating margin was partially offset by expansion of 70 basis points, which was primarily driven by sales leverage, partially offset by lapping a prior year litigation credit related to the Kraft arbitration matter. Earnings per share of $1.30, which includes a combined $0.49 benefit related to Starbucks Japan acquisition-related items, increased 83% over the prior year quarter earnings per share of $0.71, which included a $0.02 benefit from the prior year litigation credit. The Americas segment continued its solid performance in the first quarter, growing revenues by 10% to $3.4 billion, primarily driven by comparable store sales growth of 5%, comprised of a 3% increase in average ticket and a 2% increase in number of transactions, as well as revenue from 766 net new store openings over the past 12 months. Growth in food sales, attributed to both new and existing products, increased Teavana tea sales in our Starbucks retail stores, and successful limited time offering beverages, contributed to the growth in comparable store sales. Operating margin expanded 50 basis points to 24.3%, primarily due to sales leverage. Looking forward, we expect to continue to drive revenue growth and margin expansion through new stores and continued product innovation, targeted at driving growth across all geographies and dayparts, while continuing to invest in our store partners through enhancements to wages and benefits. We plan to continue to expand our beverage platforms and elevate our food program, in part with ongoing enhancements to our lunch options and the continued rollout of our evenings program. 21